Inventories Topping Out?

Jim Brown
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The morning EIA inventory report showed one more week of gains as we approach the end of the refinery maintenance season. Over the next couple weeks the trend should reverse and begin a long series of inventory declines as refiners begin ramping up for the summer driving season.

Crude inventories rose by +4.0 million barrels to 373 million and the top of the historical five year range. One more week of strong builds should push outside that range. You can see that the June-December period last year was also out of the historical range. I theorized last week that refiners are stocking up on oil just in case shooting breaks out in the Persian Gulf over the Iran nuclear problem.

Crude Oil Inventory Chart

The decline in gasoline levels continues to correspond with the drawdown of winter blends ahead of the mandatory switch over to summer fuels in May. Those winter blends have to be out of the system and that means leaving refiner tanks, flowing through the distribution system and out of the tanks at retail outlets. That requires refiners and distributors to allow stocks to deplete to zero in each tank and pipeline before they can inject the new gasoline. The gasoline inventory chart is right at the point where it should begin to rise again in early May.

Gasoline Inventory Chart

Distillate levels set a new multi year low and they are also at the point where the inventories should begin to rise. Distillate inventories have been declining since last August. This could also be a result of the various refinery closures and the removal of their storage facilities from the network.

Distillate Inventory Chart

Gasoline inventories have declined every week since February 12th and the trend has accelerated over the last three weeks. Gasoline demand at 8.496 mbpd was the lowest since the week of March 16th. High prices are taking a toll on consumer driving habits. Prices have declined from the mid $3.90s to a nationwide average of $3.84 but that is still crimping consumer budgets. I filled up today in Denver at $3.89 and that was the highest I have paid this year.

Inventory Snapshot

The two year anniversary of the Deepwater Horizon disaster produced the first arrest in the case with criminal charges being filed. A former BP employee, Kurt Mix, was arrested for intentionally destroying evidence. Nix was charged with two counts of obstruction of justice. Mix was a project engineer for BP. He was on the team attempting to estimate the volume of oil leaking from the well and attempt to stop the leak. He deleted more than 200 text messages between him and BP employees regarding the leak and the efforts to stop it. Mix reportedly emailed and texted supervisors repeatedly claiming the top-kill effort would not work because the well was gushing at three times the BP reported rate. At that time BP was claiming the well was flowing at the rate of 5,000 bpd. Mix claimed it was more like 15,000 bpd. Mix repeatedly warned the top-kill effort would fail but BP ignored his claims and continued to pursue the effort. Mix faces up to 20 years in jail and $250,000 fine on each count.

The claims by Mix the well was flowing 15,000 bpd will be detrimental to BP because that is evidence the government will use in calculating the resulting fines. It also shows BP knew the well was flowing well over its published estimates for weeks while it continued to claim the lower amount.

There will probably be more charges in the case. Two BP employees have refused to testify including one that was instrumental to actions taken on the rig.

Forecasters are predicting a cooler summer and that is going to continue weighing on natural gas and coal prices. The winter was the fourth warmest on record and that slashed consumption of those fossil fuels. Now the Weather Service is saying El Nino will produce cooler temperatures this summer. They predict May will be warmer than normal but the El Nino cooling trend will then shift high temperatures farther south and leave the U.S. cooler. In June-August 2011 we experienced the second warmest summer on record. The hottest summer dating back to 1895 was 1936.

Texas had the hottest summer last year with an average of 86.9 degrees. The previous high for a state was Oklahoma at 86.5 degrees in 1934.

Natural gas futures exploded higher today with nearly a 1% gain after a similar gain on Monday. Gas closed today at $2.07. The reason for the spike was the expiration of the futures contract this week. Short have been riding it lower to the $1.90 level last week and they all headed to the exit at once. There is still no end in sight to the buildup of gas in storage.

Some analysts are expecting a decline in production for February when the numbers are released next week. If the March numbers a month later show another decline then gas prices could begin to trend higher. Those declines in production are far from certain and at this point could be just wishful thinking. January dry gas production was 66.0 Bcfpd and the highest on record since 1973. The sharp drop in natural gas drilling rigs will eventually force a decline in production. Whether or not that happened in February is still unknown.

Natural Gas Chart

The FOMC meeting did not produce any surprises with the Fed electing to leave the statement basically unchanged and they did not extend Operation Twist that expires in June. The market reacted negatively until Bernanke reiterated in the press conference "the Fed stands ready to take additional action if needed." Traders hungry for some QE news seized on that comment like a life boat in a storm and the market rallied again. Whether that rally will continue through Thursday is up for debate. The Dow and S&P rallied only to prior resistance and failed to move higher.

The energy sector did finally catch a bid. The energy sector has been the market stepchild for the last couple months with serious underperformance. The sector has been dragged down because of low nat gas prices even those with no gas exposure. Also, everyone knows about the high oil prices but they don't believe it. They see the Iranian security premium as something that could disappear in an instant with the right words out of Iran. While I don't think that is going to happen there are analysts who believe Iran has no other choice. The vise is slowly squeezing tighter on Iran and like a trapped animal I think they will eventually react violently. That is of course assuming Israel does not attack them first.

I believe the high oil prices, for whatever reason, will continue to produce large profits for the energy sector. Exxon (XOM) and Occidental (OXY) both report on Thursday.

The futures could not make up their mind today with a spike to more than $104 then a dip to nearly $103 on inventory additions and then back o $104.50 on the falling dollar. The $100-$105 range remains in play with a break over $105 likely to start a new leg higher.

Jim Brown

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